HSBC - Further write down

HSBC announced that it will stop writing new business for its Consumer Lending business at HSBC Finance, where it had $62bn of outstanding loans at 4Q08. We remodel HSBC Holdings with a smaller operation at HSBC Finance. In 2008, HSBC reported a significant decline in capital due to mark downs taken to equity, where we show the implications should this persist. On our new forecasts, we are $2-3bn lower per annum on 2010 and 2011 estimates. We maintain our price to tangible book target at 0.7x, but on new forecasts, this results in a HK$28 target. Reiterate our SELL recommendation.

We doubt that all Consumer Lending debtors of HSBC Finance will repay their $62bn of loans. Given the fact that HSBC has taken the Goodwill charge for Household there is clear recognition of lack of value in this company and we believe, by association, in the loan book of this company. We believe that these assets will be partially marked down and likely taken straight to equity. All indications in the US are for continued high charges in N America, too.

HSBC’s results were illustrative of banking leverage risk as asset values decline. Its shareholders’ equity declined from $135bn to $100bn from securities mark downs, but also FX translation losses. Our view is that economies will deteriorate in 2009 vs 2008 and not be particularly strong in2010. The risk is therefore of more marks to equity. Even with mark downs50% less than 08A during 2009, it is possible that HSBC sees no book value improvement.

We have remodelled each region following the results announcement on Monday. While we do not replicate trading losses in forecasts years, we also do not replicated capital gains. Fundamentally we assume sharper rises in provisions in Asia, HK and South America and more subdued fee income and operating costs. We have though assumed better loan pricing in most regions. The net result is a $2-3bn reduction in 10CL-11CL per annum.

Where asset valuation is held in question, price to tangible book is more relevant. Including $17bn of new equity for HSBC and a further dividend cut, price to tangible book is 1.0x now, giving 38% downside to 0.7x.

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